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06 March 2008

The stock market appears in the news every day. You hear about it any time it reaches a new high or a new low, and you also hear about it daily in statements like "The Dow Jones Industrial Average rose 2 percent today, with advances leading declines by a margin of..."

Obviously, stocks and the stock market are important, but you may find that you know very little about them. What is a stock? What is a stock market? Why do we need a stock market? Where does the stock come from to begin with, and why do people want to buy and sell it? If you have questions like these, then this article will open your eyes to a whole new world!

What is STOCK?Imagine that you own a business. If you were to divide that business into small pieces and sell those pieces, you would essentially have issued stock. Quite simply, a share of stock is a fraction of ownership in a company.

The money you raise from selling those "pieces" of your business can be used to build new plants and facilities, pay down debt, or acquire another company. Many founders will strive to keep keep at least 51% of the stock, allowing them to retain control of the day to day activities. Any person or institution that owns over a majority of the stock is called the "controlling shareholder". Essentially, this person can do anything they want - right down to firing the CEO.

What is Stock Exchange?

If I am a private citizen who owns a restaurant, and I am selling my restaurant stock to other private citizens in the community, I might do the whole transaction by word-of-mouth, or by placing an ad in the newspaper. This makes selling the stock easy for me. However, it creates a problem down the line for investors who want to sell their stock in the restaurant. The seller has to go out and find a buyer, which can be hard. A "stock market" solves this problem.

Stocks in publicly traded companies are bought and sold at a stock market (also known as a stock exchange). The New York Stock Exchange (NYSE) is an example of such a market. In your neighborhood, you have a "supermarket" that sells food. The reason you go the supermarket is because you can go to one place and buy all of the different types of food that you need in one stop -- it's a lot more convenient than driving around to the butcher, the dairy farmer, the baker, etc. The NYSE is a supermarket for stocks. The NYSE can be thought of as a big room where everyone who wants to buy and sell shares of stocks can go to do their buying and selling.

The exchange makes buying and selling easy. You don't have to actually travel to New York to visit the New York Stock Exchange -- you can call a stock broker who does business with the NYSE, and he or she will go to the NYSE on your behalf to buy or sell your stock. If the exchange did not exist, buying or selling stock would be a lot harder. You would have to place a classified ad in the newspaper, wait for a call and haggle on a price whenever you wanted to sell stock. With an exchange in place, you can buy and sell shares instantly.

Financial Terms

Earnings per Share: The amount of profit to which each share is entitled.

Going Public: Slang for when a company is planning an IPO.IPO: Short for Initial Public Offering. An IPO is when a company sells stock in itself for the first time.Market Cap: The amount of money you would have to pay if you bought ever share of stock in a company. (To calculate market cap, multiply the number of shares by the price per share.) Short for Market Capitalization.Share: A share represents an investor's ownership in a "share" of the profits, losses, and assets of a company. It is created when a business carves itself into pieces and sells them to investors in exchange for cash.Symbol: A short group of letters that represents a particular stock (e.g., "Coca Cola" is referred to as "KO".) Underwriter: The financial institution or investment bank that is doing all of the paperwork and orchestrating a company's IPO.

The Purpose of the Stock Market

Business is the cornerstone of every economy. Almost every large corporation started out as a small, mom-and-pop operation and through growth, became financial giants. Wal-Mart, Dell Computer, and McDonald’s had combined profits of $10.34 billion this year. Wal-Mart was originally a single-store business in Arkansas. Dell computer began with Michael Dell selling computers out of his college dorm room. McDonald’s was once a small restaurant no one had heard of. How did these small companies grow from tiny, hometown enterprises to three of the largest businesses in the American economy? They raised capital by selling stock in themselves.

What Makes Stock Prices Go Up and Down?

In the introduction to the first lesson. I wrote that the entire purpose of these essays was to reach the average investor that it is possible to look at the financial statements of a company and determine what the stock is really "worth". Ideally, the investor is looking for companies that are trading below their "true" (or intrinsic) value, with the belief that someday the market will realize these securities are undervalued and the stock will rise. This reveals one of the self-evident quirks of the stock market. Sometimes companies will trade for half their value, while at other times, they will trade for 2, 3, 5, 10, or 20 or more times more than they are really worth. While this creates wild price fluctuations (known as "volatility" in financial jargon), it is the very thing that allows us, as investors, to make money.

What is a Balance sheet?

The balance sheet allows current and potential investors to get a snapshot of a company's finances. Among other things, the balance sheet will show you the value of the stuff the company owns [right down to the telephones sitting on the desk of their employees], the amount of debt, how much inventory is in the corporate warehouse, and how much money the business has to work with in the short term. It is generally the first report you want to look at when valuing a company.

Stock averages

What these averages tell you is the general health of stock prices as a whole. If the economy is "doing well," then the prices of stocks as a group tend to rise in what is referred to as a "bull market." If it is "doing poorly," prices as a group tend to fall in what is called a "bear market." The averages reveal these tendencies in the market as a whole.

What Stock brokers do exactly?

When you call up a broker at one of the companies, he or she relays your trade to the floor of the appropriate exchange, and a representative of the company (or, more commonly, a computer representing the company) makes the trade on your behalf. You pay the broker a commission (depending on the broker) to provide this service to you. Today, you can also trade stock online

Stocks that are not listed on an exchange are sold Over The Counter (OTC). OTC stocks are generally in smaller, riskier companies. Usually, an OTC stock is stock in a company that does not meet the requirements of an exchange.

Stock Simulator

Investing in the stock market can be an intimidating and complex task for many new investors. Investing brings a considerable amount of rewards, as well as risks. So, before putting your hard-earned savings on the line, why not practice with a virtual account?it's just like a game

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